An Oil Spill Darkens the Mood – March 16, 2020

The week began with news that Saudi Arabia plans to cut the price of oil and ramp up production, which sent oil prices down sharply on Monday. As the graphic below illustrates, cycles in oil can take time to play out.

In the past, a drop in oil prices would be viewed favorably. Lower prices leave us with more cash to spend, it supports consumer confidence, and it keeps inflation low.

But today, the U.S. is no longer an importer of vast amounts of oil. The shale revolution has been a game changer, and investors took a darker view and sold off on the news.

Today, the U.S. is a net exporter of oil and related products such as gasoline. Put more simply, we ship more oil and related products overseas than we import. Therefore, the oil industry is an important source of jobs and spending.

Given the concentration of high-yield debt that has fueled growth in the industry, default risks in the sector have risen.

It’s the latest in a series of concerns that has its epicenter in COVID-19, which has now been declared a global pandemic.

The enormous amount of economic uncertainty has rattled markets, as the final impact on the economy and corporate profits is difficult to forecast. In an article in the Wall Street Journal last week, former Fed Vice Chair Alan Blinder said he believes the economy will enter a recession this month.

However, Moody’s said last week it sees 2020 GDP growth at 1.5% vs its February outlook of 1.7%. Its downside scenario: 0.9%. How will this play out? We don’t know. What we do know is that action in the bond and stock markets suggest a recession may be looming on the horizon.

Bear market

On Wednesday, the Dow finished down by more than 20% from its peak, and the same happened on Thursday for the S&P 500 Index. The 11-year old bull market is officially over. A bear market has begun.

On average (This is simply an average. Past performance is no guarantee of future performance), the S&P 500 Index has taken 83 days before hitting a bear market low. And, another 63 days before officially exiting the bear market, which would require a 20% bump from the bear market low (Dow Jones Market Data, MarketWatch).

What we do know is that bull markets are followed by bear markets, and bear markets are followed by bull markets. That has been the pattern since the stock market’s inception 200 years ago. Unexpected volatility is incorporated into the long-term investment plan.

Thoughts

The U.S. is grappling with an unexpected shock that could not have been foreseen just a few weeks ago. There is some hope that a recession can be avoided if the viral outbreak is effectively mitigated by governments and global central banks.

On Thursday, the Fed announced a massive $1.5 trillion liquidity injection due to recent disruptions in the Treasury market. Unlike 2008, US banks are much stronger today, but major market volatility has disrupted credit markets. We are also seeing tighter credit conditions.

That said, we will need to see some from clarity on COVID-19 and economic activity to help stabilize stocks.

Germany, Europe’s largest economy, announced a large fiscal stimulus program.

Late Friday, House Speaker Nancy Pelosi says Democrats reached an agreement with the Trump administration on a package to respond to the economic effects of COVID-19. It’s not a panacea, but it’s designed to soften the expected blow to the economy.

We will likely see more negative headlines when testing for the virus ramps up. But a greater degree of certainty and stability on the healthcare front should lend support.

In the meantime, continue to adhere to health protocols—wash your hands, keep hands away from your face, and limit time in from of the news. Emotionally, you’ll feel better.

Created 2020-03-16 14:38:30